Definition of Terms in and Specific Exemptions for Banks, Savings Associations, and Savings Banks Under Sections 3(a)(4) and 3(a)(5) of the Securities Exchange Act of 1934

June 2, 2004

Prepared by:
Division of Market Regulation

I. INTRODUCTION

The Gramm-Leach-Bliley Act ("GLBA") was signed into law on November 12, 1999.1 Among other things, it replaced the complete exceptions for banks from the definitions of "broker" and "dealer" in the Securities Exchange Act of 1934 ("Exchange Act") with 15 functional exceptions. These functional exceptions (which we refer to as the bank broker-dealer provisions) became effective on May 12, 2001.

On May 11, 2001, the Commission adopted interim final rules ("the Rules") under the bank broker-dealer provisions.2 The Rules interpret terms used in the bank broker-dealer provisions, provide banks with specific exemptions from the definitions of broker and dealer, and extend the compliance date of the bank broker-dealer provisions. On July 18, 2001, the Commission further extended the compliance date to May 12, 2002.3 The Commission later extended the compliance date to September 30, 2003 for the dealer provisions, and to November 12, 2004 for the broker provisions.4

The Commission received over 200 letters commenting on various aspects of the Rules.5 Most of these letters came from banks or their representatives. One hundred and sixteen of these commenters submitted copies of one form letter,6 and seven of these commenters submitted copies a different form letter.7 Fourteen letters came from banking industry groups, two organizations of banking lawyers, and the Conference of State Bank Supervisors ("CSBS").8 In addition, three federal banking agencies submitted a joint letter.9 A number of the individual bank comment letters, as well as the Bank Form Letters, specifically noted that they supported or concurred with the letters submitted by the Banking Agencies, and the industry groups.10 The Commission received few comments from those outside the banking industry.

Commenters expressed their views on both the substance of the Rules and the process by which the Commission adopted the Rules. Comments regarding the process, as well as comments regarding the rules pertaining to the bank dealer provisions were discussed in connection with amendments to the bank dealer rules.11 That discussion will not be repeated here.

II. GENERAL COMMENTS ON THE BROKER RULES

Several commenters stated that the Rules represent an overly narrow interpretation of the exceptions from the definitions of broker and dealer, and are contrary to congressional intent.12 One commenter stated that the Commission is mistaken in believing that impermissible activities can easily be "pushed-out" to affiliated broker-dealers.13

Two attorneys stated that the Rules create an environment that is extremely unfriendly to their client banks.14 Other commenters stated that banks cannot be regulated by a "one size fits all" regulatory regime.15 One commenter indicated that the implementation of the Rules would be very disruptive to the ongoing business and customer relationships of banks that offer trust and other services.16

In contrast, non-industry commenters expressed general skepticism about banks' securities activities.17 The North American Securities Administrators Association ("NASAA") pointed out that in formulating the system of functional regulation, Congress realized that banks may have to change the ways in which they carry out securities activities, and "push-out" certain activities to licensed broker-dealers.18 NASAA indicated that the litmus test for the Rules is not whether they cause banks to change the way they do business, but rather whether they carry out congressionally mandated functional regulation.19 Affirming that the Rules carry out functional regulation and are consistent with the congressional intent expressed in the GLBA, NASAA expressed full support for the Rules.20

One commenter stated that the Rules provide useful guidance to banks regarding the scope of the exceptions, and afford meaningful relief in areas where investor protection concerns are minimal or are addressed under applicable fiduciary law.21 Two commenters agreed that the Rules successfully address many of the issues raised by the GLBA.22

III. SPECIFIC COMMENTS ON THE BROKER RULES

As amended by the GLBA, Section 3(a)(4) of the Exchange Act provides banks with eleven transactional exceptions for banks from the definition of "broker." Each of these exceptions permits a bank to act as a broker with respect to certain securities transactions if the bank complies with the statutory conditions. Comments regarding these provisions and the rules applicable to them are summarized below.

A. Third-Party Brokerage Arrangements

The third party brokerage arrangements ("networking") exception in Exchange Act Section 3(a)(4)(B)(i) generally permits banks to enter into contractual arrangements with registered broker-dealers to sell securities to bank customers under specified conditions. Exchange Act Rule 3b-17 defines two terms used in the networking exception: "nominal one-time cash fee of a fixed dollar amount" and "referral."

1. "Nominal One-Time Cash Fee of a Fixed Dollar Amount"

We received 34 comments on the definition of "nominal one-time cash fee of a fixed dollar amount."23 Several commenters stated that the definition is impractical, unworkable, and could create an unnecessary administrative burden.24 Some commenters thought that the definition would impose unnecessary limits on bank networking arrangements,25 and expressed particular concern that the definition could impose limits on networking compensation beyond those in the Exchange Act.26 The Bank Form Letters criticized the Rules' limitations on the amount of referral fees and expressed the view that those limitations are unfair, but did not comment specifically on the definition of "nominal one-time cash fee of a fixed dollar amount."

Some commenters contended that giving meaning to the term "nominal" would unnecessarily limit the amount or dollar value of referral fees. They maintained that the term should be left undefined or interpreted to allow market-rate referral fees up to a set amount, such as $25, $100, or $250.27 Several commenters saw no need to restrict referral payments at all.28 One commenter stated that banks should be able to pay fees more often than contemplated by the statute.29

Some commenters asserted that the definition should not list categories of factors on which referral fees could not be made contingent.30 Commenters also indicated that some banks currently limit referral fees for unregistered employees according to whether they refer customers of a certain financial status, and argued that limitations on the conditions under which referral fees may be paid are unnecessary.31

Some commenters maintained that the definition would unnecessarily limit bonuses paid to unregistered employees.32 Others opined that Congress did not intend for the networking exception's limitations on incentive compensation to affect banks' year-end bonus programs.33 Some commenters stated that a bonus program applicable to all employees of a bank holding company, or based on the profitability of a bank holding company as a whole, should not be affected by these limitations.34

While some commenters supported the definition's provision permitting the payment of referral fees in points rather than in cash, others asserted that it should not be limited to points awarded for securities referrals as part of a broader program also rewarding a range of banking and other non-securities related services.35 Some commenters took the position that under the definition, fees based on points for activities involving non-securities products and services would be limited to excessively low amounts.36

2. "Referral"

We received over a dozen comments on the definition of "referral."37 Some commenters characterized the definition as excessively narrow,38 and generally took the position that it was more restrictive than required by the Exchange Act, the Federal Banking Agencies' Interagency Statement on Retail Sales of Nondeposit Investment Products,39 and the staff's Chubb letter.40 Two commenters either objected to the use of the phrase "first securities-related contact" in the definition, or suggested that the phrase should be defined.41

B. Trust and Fiduciary Activities

The trust and fiduciary activities exception generally allows banks to act as brokers and dealers in securities so long as they act as "trustees" or fiduciaries" and meet other conditions.

1. Definition of Terms in Rule 3b-17

Rule 3b-17 defines seven terms used in the trust and fiduciary activities exception: "chiefly compensated;" "relationship compensation;" "sales compensation;" "flat or capped per order processing fee equal to not more than the cost incurred by the bank in connection with executing securities transactions for trustee and fiduciary customers;" "indenture trustee;" "investment adviser if the bank receives a fee for its investment advice;" and "trustee capacity."

We received 37 comments on the definition of "chiefly compensated."42 The comments generally centered on four issues: (1) manner of calculation; (2) types of compensation (i.e., relationship compensation and sales compensation); (3) risk of inadvertent non-compliance; and (4) compliance costs.

1. Manner of Calculation

Five commenters stated that the Rules reasonably defined the term "chiefly" to mean more than 50 percent of relationship compensation versus sales compensation, and indicated that the definition should be implemented with that meaning.43 One commenter expressed the view that the chiefly compensated condition may not be interpreted to require a higher threshold than 50 percent.44

Two commenters agreed with the provision to allow banks to determine whether they meet the chiefly compensated standard on an annual, rather than quarterly, basis.45

Many commenters discussed the manner in which the chiefly compensated determination must be made in accordance with the definition. Although one commenter believed that an account-by-account approach might make sense for smaller banks,46 many opposed this approach generally. For example, some commenters stated that an account-by-account analysis is unnecessary, unworkable, inappropriate, and burdensome.47 Several commenters noted that banks currently receive revenue from a variety of sources and they do not have sophisticated systems in place to track revenues on an account basis.48

One commenter believed that imposing the chiefly compensated analysis on every account could interfere with banks' traditional trust and fiduciary activities.49 Two commenters indicated that there may be instances in which a bank would be required to engage in a significant number of securities transactions for an account in a trust department, such as when an account is opened, due to the investment policy of the bank and the governing trust instrument.50 These commenters also stated that bank trust departments engage in a high volume of securities transactions near year-end for tax purposes. They expressed concern that such concentrated transactions in an account could prevent the account from qualifying as chiefly compensated by relationship compensation. Another commenter believed that an account-by-account calculation is, in effect, a recordkeeping requirement for banks, and noted that banks' recordkeeping rules are the province of the federal banking agencies, and not the Commission.51

Some commenters favored a line-of-business calculation.52 One of these commenters noted that a line-of-business approach would address situations in which a bank provides multiple services to a customer (such as checking, trust, or mortgage services) and negotiates fees to cover all of the services, as well as situations in which one account pays for other related-party accounts.53 Several commenters thought the calculation should apply to a bank's entire trust department on an aggregate basis.54

2. Types of Compensation

Several commenters addressed the types of compensation (relationship compensation and sales compensation) that must be compared in the chiefly compensated calculation.

i. Relationship Compensation

We received 15 comments on the definition of "relationship compensation."55 Two commenters stated that the definition of relationship compensation, as well as the definitions of sales compensation and unrelated compensation, are overly complicated, create huge compliance burdens for the banking industry, and are not called for by the GLBA.56 The Banking Agencies maintained that this definition unnecessarily limits the ability of bank trust departments to tailor account and reimbursement arrangements to the needs of particular fiduciary clients.57

Commenters noted that the statute does not specifically require compensation to be "received directly from a customer."58 One bank questioned how this requirement could be implemented in the case of multi-participant 401(k) plan accounts.59 Another bank argued that there is no basis in the statute or in the legislative history for fees, such as special service fees related to management of non-securities assets that are typically charged by fiduciaries, to be categorized as "unrelated" compensation rather than "relationship" compensation.60

One commenter stated that the many types of fees that are required to administer all types of account assets are within the fiduciary responsibilities of banks and should be considered sources of relationship compensation, particularly the litigation and tax return fees incurred in the administration of an account.61 Six commenters asserted a fee waived by a bank (because the bank or an affiliate is being compensated separately) in compliance with the Employee Retirement Income Security Act ("ERISA") or other laws should nonetheless count as relationship compensation.62 Commenters also argued that any other compensation received by a bank in lieu of those fees should not be treated as sales compensation.63

Two commenters noted that the "source of funds" requirement in the definition does not consider banks' practice of structuring fees based on an entire relationship, often within an extended family.64 They explained that fees compensating a relationship may be payable from non-fiduciary assets held by the bank, a bank affiliate, or someone else (other than the accountholder).65 One commenter also urged the Commission to "grandfather" revenues received under pre-existing fiduciary relationships as "relationship compensation."66

One commenter maintained that the definition of relationship compensation should be expanded to encompass banks' recovery of any reasonable costs associated with order processing.67 Two commenters thought the definition was too narrow because it excludes fees for managing non-securities assets if those fees are separately charged.68 These commenters also asked the Commission to clarify whether fees for managing non-securities assets may be included in relationship compensation if those fees are not separately charged.69 Several banks and trade groups argued that compensation paid by a mutual fund from 12b-1 fees should be included in relationship compensation.70 One bank agreed, however, that 12b-1 fees should not count as relationship compensation when they are specifically determined to be fees for providing distribution-related shareholder services.71

One commenter pointed out that Section 21 of the Glass-Steagall Act prohibits banks from "distributing" securities.72 This commenter explained that for Glass-Steagall purposes, 12b-1 fees are not viewed as distribution fees, but rather as fees for providing administrative services.73 In this commenter's view, it would be more appropriate to treat 12b-1 fees as they are treated under the Glass-Steagall Act, rather than as they are treated under NASD rules that were developed for entirely different purposes.74 This commenter recognized, however, that under NASD rules 25 basis points of 12b-1 fees may be for administrative services.75 Thus, this commenter argued that even the full amount of 12b-1 fees is not considered as relationship compensation, the portion of 12b-1 fees that is considered service fees under NASD rules should be considered as relationship compensation.76

ii. Sales Compensation

We received 18 comments on the definition of "sales compensation."77 Eleven commenters argued that 12b-1 fees and shareholder servicing fees should not be characterized as sales compensation.78 One bank trade group and one bank stated they could find no basis for the Commission's determination that sales compensation should be measured only against fees for managing securities accounts, and not against other fees received in connection with trust accounts.79 Four commenters stated that 12b-1 fees should be treated as either unrelated or relationship compensation.80 Two of these commenters stated that because 12b-1 fees are paid based on the amount of assets in an omnibus account, it would be difficult to allocate such fees on an account-by-account basis.81

One mutual fund pointed out that the federal banking agencies have already addressed the requirements that banks must meet, in light of state fiduciary requirements, before accepting 12b-1 fees or service fees.82 This commenter also noted the reference in GLBA legislative history indicating that Congress did not intend for bank trust departments to develop a "salesman's stake" by collecting brokerage commissions or other similar compensation for effecting securities transactions.83 Another mutual fund explained that under trust law, bank trustees are not permitted to receive sales commissions.84 This commenter concluded, therefore, that 12b-1 fees cannot be considered sales compensation.85

One mutual fund also stated that there is no evidence in GLBA legislative history to indicate that Congress intended to limit a bank's ability to provide administrative services to investment companies.86 Other commenters argued that any shareholder servicing fees that are not considered sales compensation should be considered relationship compensation instead of unrelated compensation.87 One commenter urged the Commission to consider shareholder servicing fees as relationship compensation, reasoning that because these fees are paid out of mutual funds assets, they are a direct charge against the assets of fund shareholders, and therefore should be considered as paid directly by trust beneficiaries.88

Other commeners, including two banks, asserted that because 12b-1 fees and service fees comprise most of the compensation that banks receive for ERISA trust accounts, banks with these accounts could never be in compliance with the trust and fiduciary exception.89 These banks indicated that this would require banks to charge plans significantly higher initial and ongoing administrative fees, which in turn would make their ERISA products non-competitive.90 Another bank expressed the opinion that the mutual fund industry has used term "12b-1 fees" generically, and that while many agreements refer to a 12b-1 distribution plan, the services provided under the agreements are more administrative than distribution-related.91 In this bank's view, banks should not be bound by the mutual fund industry's characterization of 12b-1 fees because individual banks do not have the power to change the funds' business practices.92

Some commenters maintained that 12b-1 fees should be defined as relationship compensation, not sales compensation, when a bank is required by law (e.g., ERISA) to use 12b-1 fees received in connection with services provided to a fiduciary customer for the benefit of that customer.93 One commenter stated that the Commission should exempt ERISA accounts and self-directed IRAs in its treatment of 12b-1 fees and service fees as sales compensation.94 This commenter opined that service fees are administrative in nature and have no impact on shareholder returns because they are paid out of an investment company's management fees.95

The Banking Agencies and two banks also urged the Commission to clarify that sales compensation does not include compensation or fees received by, or paid to, bank employees.96

iii. Comparison of Compensation

NASAA stated that by comparing relationship and sales compensation, the definition ensures that traditional trust activities may remain in the bank, while activities in which the bank has a "salesman's stake" are pulled out of the bank.97 This commenter argued that anything less than an account-by-account calculation could enable banks to use the trust and fiduciary activities exception to conduct brokerage activities outside the securities laws through a "private banking" or similar program.98 This commenter also stated that the number of statutory conditions placed on this exception reflects Congress's intent for it to be narrow.99

Some commenters believed that the definitions of sales and relationship compensation require an overly complicated analysis to separate them.100 One commenter stated that all trust compensation, regardless of whether it is related to securities transactions, should be included in the chiefly compensated calculation.101 Two others maintained that the GLBA does not limit the sources of a bank's compensation, and that the requirements of the chiefly compensated test could be met without limiting qualifying compensation to fees paid directly by trust accounts.102 They also pointed out that fiduciary law bars a trustee from receiving sales commissions, and concluded it is unlikely that a bank trust department would be engaged in a retail brokerage business.103

One commenter stated that the chiefly compensated test is inappropriate, in part, because it does not permit a bank to count certain fees as relationship compensation, including 12b-1 fees, shareholder servicing fees, and sub-transfer agent type fees, as well as traditional non-securities income generated from investment in real estate, oil, and gas.104

Two commenters stated that a bank may offset 12b-1 fees against trustee fees to comply with Department of Labor interpretations under ERISA.105 Two commenters stated that the calculation could effectively require them to "push-out" their 401(k) pension plan administration business to a broker-dealer, explaining that plan sponsors traditionally prefer to pay service providers in the form of 12b-1 or shareholder servicing fees from mutual fund companies.106

One commenter recommended that the Commission "grandfather" trust and fiduciary arrangements that were entered into prior to the establishment of the parameters for categorizing compensation.107

3. Risk of Inadvertent Non-Compliance

Several commenters noted that it would be possible for a bank to come out of compliance with the exception based on one account.108 Without any type of cure period, these commenters stated that banks would continually be at risk for unintentional violations of the securities laws.109

4. Cost of Compliance

Some commenters estimated that the cost of implementing systems to track and calculate the three types of compensation would be prohibitive, and could require banks to restructure customer relationships, which could also impose significant costs.110 These commenters pointed out that banks would incur expenses for implementing new recordkeeping systems, which could result in higher fees for their trust customers.111 Another stated that it has over 200 codes to categorize various fees that could be charged to trust, fiduciary, and custody accounts, and estimated it will cost over $1 million to implement appropriate compliance systems. This commenter also indicated that it would have difficulty categorizing some of its fees.112 One commenter stated that banks simply do not maintain the types of records that would be needed to perform the chiefly compensated calculations.113

Two commenters estimated that the account-by-account calculation would require a yearly analysis of fees charged to over 19 million accounts that are valued at over $22 trillion.114 One commenter stated that it has over 80,000 trust and agency appointments representing more than one trillion dollars in outstanding securities.115 Another stated that it has in excess of 28,000 trust and fiduciary accounts and that an account-by-account calculation would require it to develop separate tracking systems for each of its billing systems.116 Another commenter noted that an account-by-account calculation would require it to hire additional staff just to perform calculations for over 10,000 accounts.117 One commenter stated that it would have to analyze 19,000 accounts every year.118

One bank estimated that it will require 12 to 18 months to develop monitoring systems to comply with this definition.119 Another commenter stated that it does not have tracking systems in place and estimated that it would take 18 to 24 months to develop and install the necessary software and train associates to do the required calculations, at a cost of roughly $1-2 million.120 Two commenters cited a very large bank's estimate that its total technology cost to comply with all the new requirements would be $15 million, and stated that banks would have to spend millions of dollars to comply with an overly complex formulation of the chiefly compensated standard.121

One commenter stated that it maintains distinct vendor-developed data processing systems for its trust and brokerage accounts, and noted that transferring accounts between systems creates the potential for errors and could have a disruptive impact on customers.122 Another stated that the definition of chiefly compensated may place banks in the position of having to choose between "pushing-out" many traditional trust and fiduciary activities into a broker-dealer, or completely restructuring their compensation arrangements in a way that is very different from current industry standards.123 Another commenter stated that, for smaller banks, the accounting exercise alone is likely to erode trust income.124

b. Flat or Capped per Order Processing Fee Equal to Not More Than the Cost Incurred by the Bank in Connection with Executing Securities Transactions for Trustee and Fiduciary Customers

We received ten comments on the definition of "flat or capped per order processing fee equal to not more than the cost incurred by the bank in connection with executing securities transactions for trustee and fiduciary customers."125 Several commenters indicated that this definition creates problems for banks because bank employees who handle trust trades have other administrative duties.126 Five commenters argued that they could find no statutory basis for the limitations in this definition.127

Two of these commenters expressed the view that this definition is more restrictive than their reading of the GLBA, which they believe would allow banks to be compensated for any costs associated with order processing.128 They explained that, especially in smaller banks, individuals may perform more than one function and not be exclusively devoted to securities transaction processing. Alternatively, they indicated that a bank may outsource these responsibilities to make more efficient use of existing resources. In their view, it does not make sense to preclude a bank from recovering the costs of those activities merely because the individual involved is not exclusively devoted to securities order processing.129 One industry group also stated that dedicated resources should include either the cost of shared resources, general overhead allocation, or a return on capital.130

One bank indicated that the limit in this definition would prevent it from fully recouping the costs it believes are properly allocable to shared resources.131 This commenter also argued that it is unfair to exclude the entire amount of a per order processing fee if only a portion of the fee exceeds the bank's cost. In its view, banks should be permitted to treat as permissible relationship compensation the cost of any resources, including shared resources that a bank can prove are allocated to executing and settling securities transactions on behalf of trust and fiduciary accounts.132 Another commenter asserted that a bank should be allowed to demonstrate that a portion of an individual's time dedicated to this process is a cost for purposes of determining a flat or capped per order processing fee.133 Another bank commented that the reference to an "order" processing fee should not be construed as extending to clearing and settlement services, which this commenter stated are distinct activities that banks have long performed for all trust, fiduciary and custody clients.134

Two commenters explained that trade execution functions are generally consolidated into one central place, which allows trades to be conducted on a more economical basis and ensures that trades are not improperly allocated among the various accounts serviced by a bank.135 Because these central trading desks often perform trade execution functions for bank affiliates, these commenters maintained that exclusivity could not be assured. Two commenters specifically asked the Commission to eliminate the exclusivity requirement included in the definition.136

Another commenter noted that the release adopting the Rules cited an OCC position that has changed.137 Citing the OCC's Handbook on Conflicts of Interest, this commenter explained that the OCC now permits national banks to effect securities transactions for fiduciary accounts through an affiliated broker-dealer.138

c. Indenture Trustee

We received three comments on the definition of "indenture trustee."139 Two commenters stated that because trustee appointive documents are not limited to indentures, the definition should be expanded to include trustees appointed pursuant to pooling and servicing agreements, trust agreements, bond resolutions, and mortgages.140 One commenter argued that banks act in a fiduciary capacity when serving as indenture trustees under the Trust Indenture Act of 1939, and also requested an exemption from broker-dealer registration.141

d. Investment Adviser if the Bank Receives a Fee for its Investment Advice

We received 23 comments on the definition of "investment adviser if the bank receives a fee for its investment advice."142 One commenter stated that this definition is appropriate because it is consistent with current investment adviser law.143 Another commenter stated that the "continuous and regular" requirement in the definition is consistent with its understanding of how such activities are performed by bank trust departments, and urged the Commission to provide a safe harbor for banks if they review customers' accounts at least annually.144 This commenter also suggested that banks' periodic rebalancing of asset allocation models should be viewed as providing "continuous and regular" investment advice.145

Many commenters argued the definition was either contrary to their reading of the statute, inconsistent with their interpretation of congressional intent or, in their view, too restrictive.146 One commenter noted that a one-time portfolio review might be all the investment advice a customer ever wants or needs.147 Another commenter maintained that a "continuous and regular" requirement could place undesirable pressure on banks to recommend inappropriately frequent transactions in a customer's investment account.148 Another commenter suggested that banks should be able to rely on the exception if they provide advice that is based principally on market events.149

Three commenters urged the Commission to eliminate the requirement in the definition that a bank have a duty of loyalty to its customers.150 The Banking Agencies echoed this view, maintaining that although a duty of loyalty may arise as a consequence of a bank or other person acting as an investment adviser, the duty is not a precondition to acting as an investment adviser.151 While the Banking Agencies agreed that banks providing investment advice for a fee have fiduciary obligations to their customers, including the duty to disclose potential conflicts of interests, they asserted that the bank regulation and examination process provides the most appropriate method for ensuring compliance by banks with these important duties.152

Other commenters argued that a duty of loyalty is not determinative of whether an entity or individual is functioning as an investment adviser.153 Noting a duty of loyalty is derived from bank regulation, ERISA, federal tax law, state statutes, common law, and case law, commenters stated there is no need for the federal securities laws to impose a duty of loyalty on banks.154 Another commenter maintained that it would not be appropriate for the Commission to scrutinize the fiduciary disclosure obligations of banks because disclosure of material facts relating to fiduciary conflicts of interest is an area that has historically been regulated by state fiduciary laws.155

e. Trustee Capacity

We received 27 comments on the definition of "trustee capacity."156 Some commenters supported the definitional exemption for indenture trustees and trustees for certain tax-deferred accounts.157 However, commenters also argued that the exemption should be expanded to cover banks acting as custodial trustees for IRA accounts.158 They also pointed out that the exemption should not exclude either indenture trustees operating under appointive documents other than indentures, or indenture trustees serving on issues or transactions that may not be covered by the definition.159 Some commenters urged the Commission to withdraw the definitional exemption and interpret the trust and fiduciary activities exception as covering all types of trustees.160 Several commenters argued that defining trustee capacity as including an indenture trustee or a trustee for certain tax-deferred accounts creates ambiguity by suggesting other trustees may not be able to rely on the trust and fiduciary activities exception.161

One commenter disagreed with the discussion of trustee relationships in the release adopting the Rules because this commenter viewed it as focusing on whether a bank exercises investment discretion.162 In this commenter's opinion, there are numerous trustee relationships in which a bank may not exercise investment discretion, but would be subject to fiduciary duties, including personal trusts, charitable foundation trusts, insurance trusts, rabbi trusts, and secular trusts, conservatorships, and guardianships.163

Two commenters maintained that state and federal fiduciary law, not the Commission, should determine the nature of a trust or fiduciary relationship of a governing trust instrument.164 One commenter stated that it is unclear how banks could push out trust accounts to broker-dealers.165 Three other commenters agreed, noting that banks are appointed to trustee and other fiduciary capacities under the terms of instruments that incorporate requirements from both state law and common law and state statutory qualifications for fiduciaries, and stated that accounts cannot be readily transferred to a broker-dealer under applicable law.166

2. Aggregate Compensation Exemption

We received 29 comments on the "aggregate compensation exemption."167 The Banking Agencies and a bank trade group agreed that banks need relief from an account-by-account calculation requirement.168 One mutual fund indicated that the vast majority of the 130 banks that sell its funds would qualify for the ten percent exemption.169 However, this commenter, as well as several banks, noted that banks would welcome a percentage greater than 10 percent in this exemption.170 Two banks urged the Commission to increase the exemption from 10 percent to 25 percent.171

Two commenters indicated that although they agreed that banks should be able to calculate compensation using an aggregate method on an institution-wide basis, they found the 10 percent safe harbor to be unreasonably low.172 They also noted that banks would need to do overall daily monitoring on an aggregate basis to ensure that they remain within the safe harbor.173 One commenter stated that if the Commission does not adopt an aggregate compensation method, it should increase the safe harbor from 10 percent to 50 percent.174 Two other commenters urged the Commission to raise the safe harbor from 10 percent to at least 33 percent.175

Two commenters viewed the 10 percent limit as arbitrary and as an unnecessarily severe reduction of the 49 percent threshold otherwise provided by the Rules.176 Two commenters stated that the 10 percent limit is too low, and argued that it and either departs from, or bears no relation to, the concept of "chiefly."177 One of these commenters view stated that the comparison should be between "sales compensation" and the sum of "sales compensation" and "relationship compensation."178

The Banking Agencies, along with several banks and bank trade groups, stated that the conditions to the safe harbor exemption essentially require an account-by-account calculation, thereby defeating the purpose of the exemption.179 One commenter also stated that it would be impossible for banks to comply with the procedural requirement to review an account for compliance with the "chiefly" test when "sales compensation" is reviewed for purposes of determining an employee's compensation.180 This commenter explained that these reviews may be done numerous times by employees with no knowledge of the "chiefly compensated" requirements.181

One commenter indicated that implementing procedures to take advantage of the aggregate compensation exemption would require banks to build costly new systems.182 One commenter urged the Commission to eliminate the review procedure so that banks could adopt across-the-board fee increases without triggering an account-by-account compliance review.183 Another commenter suggested that the safe harbor could be based, at least in part, on a bank's fee schedules for trust and fiduciary accounts.184 In this commenter's view, if a bank's fee schedules provide that relationship compensation exceeds sales compensation for a given type of account, there should be a presumption that all accounts of that type -- including accounts discounted on a straight percentage basis from the fee schedule -- satisfy the chiefly compensated test.185 In addition, if the SEC does not treat 12b-1 fees as relationship compensation, the safe harbor should include a presumption that a certain percentage of 12b-1 fees (e.g., 80 percent) be treated as relationship compensation.186

3. Indenture Trustee Compensation Exemption.

We received two comments on the indenture trustee compensation exemption. One commenter stated that the definition of indenture trustee should be reframed in as broad a manner as possible so as not to exclude either indenture trustees operating under appointive documents other than indentures, or indenture trustees serving on issues or transactions that may not be captured under either Section 303 or Section 304 of the Trust Indenture Act of 1939 ("TIA").187

One commenter stated said that by narrowly defining the exemption for corporate trust activities in terms of "indenture trustees" and the TIA, the rule would require banks to "push-out" activities that they have historically performed in their fiduciary capacity through their corporate trust departments.188 This commenter further noted that the central characteristic of these activities is the administration of complex, customer contracts that require compliance assessment of: (1) the parties' covenants and performance obligations; (2) the necessity to calendar compliance requirements based upon specific contract terms; and (3) the continuing need to monitor acts or omissions of the parties to determine whether they are authorized or permitted by the terms of the governing account documents.189 According to this commenter, these activities include performing directed investment services while acting as trustee under an indenture not qualified under the TIA (e.g., private placements, equity securitizations, and tax exempt securities), acting as trustee under appointive document (e.g., loan agreements, servicing agreements, and custom investment contracts), and acting in a non-trustee capacity (e.g., escrow agent, commercial paper issuing and paying agent, debt securities paying agent, distribution agent, collateral agent, custodian for mortgage loan files, and as exchange accommodation titleholder or qualified intermediary in like kind exchange transactions).190 This commenter urged the Commission to clarify that the terms "indenture trustee" and "indenture" should be interpreted as illustrative terms.191 This commenter also opined that these functions are ill-suited to be "pushed-out" to broker-dealer dealer affiliates and that sufficient investor protection is provided in the broader range of traditional corporate trust departments activities.192

4. Department Regularly Examined

Although the Banking Agencies and two banks expressed support for the Commission's decision to rely on the Banking Agencies to determine if activity is conducted in an area regularly examined for fiduciary principles, they also stated that the Commission's view on the examination requirement in this exception is inconsistent with how banks operate. In their opinion, the Commission's approach will artificially constrain normal business activity, and may prevent banks from utilizing the trust and fiduciary activities exception, because the Rules do not recognize that banks delegate securities processing and settlement functions to separate departments or affiliates for cost or operational efficiencies.193

Commenters also stated that the regularly examined for fiduciary principles requirement is overly restrictive and ignores the fact that applicable banking regulations permit certain functions to be outsourced to other departments, affiliates, and even third parties.194 Some banks and bank trade groups stated that banks may use the trading desk of a registered investment adviser to process trades on fiduciary accounts, or bank fiduciaries may find it more economical to outsource certain trust back office functions.195 One bank and a bank trade group argued that requiring "all aspects" of transactions to be included is overly broad and could unduly restrict new business and cross-selling efforts by commercial new business officers and other non-trust department associates.196 These commenters also indicated it could restrict the performance of back office functions, such as routing orders and sending out confirmations.197 One commenter stated that many small banks do not have trust departments and may also offer IRAs through their normal retail branch activities.198

The ICBA urged the Commission to "clarify" that it is the activity that will qualify for the exception, rather than where the activity is conducted.199 One bank stated that only those bank departments, affiliates, or third-party providers that have fiduciary relationships with customers should be regularly examined for compliance with fiduciary principles.200 One bank urged the Commission to withdraw its guidance in this area.201

5. "Similar Capacity"

Section 3(a)(4)(D) of the Exchange Act defines "fiduciary capacity" for purposes of the trust activities exception by listing certain capacities and "any other similar capacity." The Banking Agencies expressed appreciation for the Commission's efforts to identify instances in which model codes or state laws use different terminology and to clarify that particular activities are encompassed by the exception.202 This interpretation was contained in the text of the Release and is not set forth in a rule.

One commenter stated that bank performing escrow services should be considered to be acting in a similar capacity to an indenture trustee.203 Another commenter stated that although non-trustee capacities -- such as escrow agent, commercial paper issuing and paying agent, debt securities issuing and paying agent, distribution agent, collateral agent, custodian for mortgage loan files, exchange accommodation titleholder, and qualified intermediary -- are not similar capacities to that of an indenture trustee, they should nonetheless be considered bank fiduciary capacities.204 Commenters also specifically argued that a bank performing escrow services should be considered to be acting in a similar capacity to an indenture trustee.205 One commenter stated that banks performing an escrow function should be deemed to be acting in a fiduciary capacity, without prejudice, however, to their ability to rely on the exemption for custodial activities.206

Some commenters noted that the definition of "fiduciary capacity" in Exchange Act Section 3(a)(4)(D) is similar to the definition of the same term in the OCC's regulations.207 Because of this similarity, these commenters urged the Commission to view the Exchange Act definition as including all the activities listed in the OCC regulations.208

Several commenters stated that Congress intended to permit banks to continue to engage directly in certain traditional activities involving securities transactions.209 In their view, Congress did not intend for a major policy shift to restrict banks' ability to offer traditional bank trust and fiduciary services.210 The Banking Agencies and another commenter stated that compliance with the examination process of banks should be the only inquiry.211

One commenter asserted that, because banks are subject to standards of prudence and strict loyalty under the Uniform Prudent Investor Act, the Commission should consider this context in interpreting the bank trust exception.212 Three commenters stated that the nature of a trust and fiduciary relationship might vary, but it is ultimately determined by the governing trust instrument, common trust law, state and federal fiduciary law, and various other laws and regulations -- all of which should be interpreted by the courts, not the Commission.213 Several commenters maintained that bank regulators have successfully regulated banks' trust activities for years.214 Two commenters indicated that the Commission failed to take into account the extensive fiduciary requirements that other laws impose on bank trust and fiduciary activities and overlooks the existing supervisory framework that the Banking Agencies have established to supervise these activities.215

6. Restriction on Advertising

One commenter indicated that the restriction on soliciting brokerage business, other than by stating that the bank effects transactions in conjunction with advertising its other trust activities, needs clarification.216 This commenter expressed particular concern about the types of informational materials that may be placed on a bank's website in connection with a bank's proprietary mutual funds and other types of securities.217

C. Sweep Accounts

Rule 3b-17 defines two terms used in the sweep accounts exception: "money market fund" and "no-load." We received no comments on the definition of "money market fund."

We received 29 comments on the definition of "no-load."218 One commenter expressed the view that defining the term consistent with the NASD definition of "no-load" was "logical and appropriate."219 Some commenters, however, asserted that the term should be interpreted much more narrowly to mean only that a fund is not subject to front-end or back-end sales charges, arguing that this would be consistent with congressional intent.220 Some commenters claimed that the Commission's definition of "no-load" would require banks to revise their sweep programs, which would involve significant administrative expense for banks, as well as inconvenience for bank customers.221

One mutual fund noted that many investment companies offer multiple classes or series of shares, and that some, but not others, may be subject to sales loads or deferred sales loads. This commenter suggested amending the definition to reflect this fact.222

D. Safekeeping and Custody Activities

Rules 3a4-4 and 3a4-5 provide conditional exemptions for banks to engage in limited brokerage activity for custody accounts. We received comments on both exemptions.

1. Conditional Exemption for Small Banks

Rule 3a4-4 provides a conditional exemption to allow small banks to effect transactions in investment company securities held in tax-deferred custody accounts and to be compensated for this brokerage activity. We received 17 comments on this exemption.223

Six commenters stated that the exemption has too many conditions and is unworkable.224 One trade group stated that the conditions place banks at a competitive disadvantage to other financial service providers that offer custodial IRA accounts.225 In this commenter's view, banks should be allowed to conduct securities transactions through any registered broker-dealer on behalf of their safekeeping and custodial account customers without other constraints, as intended by Congress.226 One mutual fund indicated that there is no market for an IRA account that does not allow the account holder to conduct transactions in the account, and stated that it is unlikely Congress would have provided an exemption allowing banks to act as custodians for IRA accounts without allowing them to effect transactions for those accounts.227 The Banking Agencies and one bank specifically addressed the conditions on advertising, stating that they are overly broad and would prohibit banks from engaging in advertising activities that are expressly permitted by the GLBA.228 One bank urged the Commission to eliminate the condition that banks offering proprietary mutual funds must also offer nonproprietary funds.229

Commenters also indicated that the three percent cap on annual revenue in the exemption severely constrains small banks.230 In their view, the exemption should not be limited to providing order-taking services for clients seeking mutual funds, but should include services to tax-deferred accounts holding corporate debt and equity securities.231

One commenter stated that there is no basis in the GLBA for differentiating between small and large banks.232 Another commenter pointed out that the Banking Agencies define a small bank as one with less than $250 million in assets.233

The Association of Independent Trust Companies ("AITC") stated that while the definition is generally understandable for a traditional bank, it is confusing with respect to trust companies.234 Moreover, the AITC noted that it is difficult to apply a three percent revenue limit to a trust company. The AITC indicated that because trust companies do not make loans, their assets are generally less than $100 million; however, their assets under management generally exceed $100 million. The AITC asserted that small trust institutions should be exempted from Commission regulation because it adds an unnecessary additional burden.235

The Council of Insurance Agents & Brokers ("CIA&B") urged the Commission to rescind this exemption, noting that insurance agents and brokers compete with savings banks and thrifts for customers, and arguing that this exemption gives banks and thrifts an unfair competitive advantage.236 In the alternative, this commenter suggested amending the exemption to include small insurance agents and brokers. In the view of the CIA&B, it would be more defensible to exempt small insurance agents and brokers than small banks, both because of their relatively smaller sales volume, and because of the potential for customer confusion at banks that offer insured deposit accounts.237

In contrast, one commenter questioned the exemption entirely, asking why the Commission would want to deprive investors who place securities orders with their custodial banks of the consumer protections afforded to them by dealing with individuals who have received the important securities training that comes with being an associated person of a broker-dealer.238

2. Rule 3a4-5, Conditional Exemption for All Banks

Exchange Act Rule 3a4-5 conditionally exempts all banks that effect transactions in securities for custody accounts without, directly or indirectly, receiving compensation for providing this service. We received 39 comments on this exemption.239

Commenters generally asserted that Rule 3a4-5 imposes unwarranted restrictions and conditions on banks, and is inconsistent with the GLBA and congressional intent.240 For example, one commenter stated that the rule "unduly" restricts the ability of banks to rely on the safekeeping and custody exception by limiting the fees that banks may charge as custodians for order taking and other "limited" execution services.241 This commenter maintained that "custody and safekeeping" has traditionally been understood to include order taking and that the GLBA did not change this understanding.242 Moreover, this commenter stated the rule is unnecessary and contains requirements that cannot be met without placing substantial and unnecessary burdens on banks.243

Another bank explained that an important aspect of its custody business has historically been taking orders to execute securities transactions for custody clients.244 This commenter maintained that this service is not provided as a substitute for the brokerage business, but rather as an accommodation and convenience for clients.245 In this commenter's opinion, the rule's requirements are unworkable and would have a severe negative impact on its custody business.246

This commenter also stated that the rule is unnecessary because the GLBA custody exemption was intended, in part, to permit banks to continue providing order taking and other execution services incidental to custody and safekeeping.247 Another commenter strongly urged the Commission to withdraw the rule, stating that because Exchange Act Section 3(a)(4)(B)(viii) is clear and unequivocal, an exemptive rule is unnecessary.248

Several commenters considered the conditions of the exemption. The Banking Agencies stated that the conditions placed on advertising are overly broad and would prohibit banks from engaging in advertising activities that are expressly permitted by the Act.249 Several commenters indicated that the prohibition on dually licensed employees taking orders is contrary to the Commission's contention that registration provides important investor protections.250 One commenter stated that the restriction on dual employees is problematic because banks and their affiliates often combine back office and other operations.251

Other commenters found the employee compensation provisions of the rule to be troubling, arguing that banks should be able to reward their employees for securing new custodial business.252 One bank stated that requiring the employee taking orders to primarily perform duties for the bank other than effecting transactions in securities for customers restricts a bank's ability to staff custody accounts as it deems most appropriate, with no perceivable advantage to, or protection for, its customers.253

One commenter asserted that the prohibition on paying referral fees is particularly inappropriate, given that such fees would encourage the movement of clients to a registered broker-dealer. This commenter also stated that bank custody departments deal with persons (usually institutions) with holdings large enough to warrant having a bank as a custodian, and indicated that this is the least likely context for referral fees to raise concerns.254 This commenter also urged the Commission to adopt its view and explicitly state that the exemption does not restrict the payment of incentive compensation to employees of bank custody departments who introduce new custodial customers to the bank.255

One commenter stated that because the exemption does not permit banks to accept orders for self-directed IRA and custody agency accounts and be compensated for them, the exemption unnecessarily complicates its business in this area.256 Another commenter argued that preventing banks from receiving compensation for trading in IRA custodial accounts would require banks to operate at a loss.257 Two commenters suggested that the Commission expand the rule to permit banks to recover the costs associated with processing trades for their custodial customers.258 Three commenters asserted that the prohibition on transaction-related compensation is overly restrictive.259 One bank stated that the compensation prohibition for custodian banks effecting trades would require banks to provide certain aspects of its custodial service at a loss, which would be inconsistent with congressional intent to protect customary banking activities.260

One commenter argued that the GLBA does not require banks to provide securities clearing and settlement services for free.261 This commenter described the rule as at odds with banks' legitimate goal of creating a fair fee structure to charge customers according to the level of services customers use.262 Commenters also indicated that the rule's approach would cause banks to increase their base trustee and custody fees to cover the costs of providing "free" clearing and settlement services to those accounts in which securities transactions occur.263 One commenter maintained that fees for clearance and settlement services should not be disturbed, so long as the fee for those services does not increase if the bank takes the client's securities order.264

Eight commenters argued that banks should not have to offer non-proprietary funds if they offer proprietary funds.265 In their view, offering their competitors' funds would increase their operational costs as the number of investment options increases.266 For example, Mellon Bank stated that this condition would unfairly require banks to search out competitors' mutual funds to offer to customers who direct their own trades.267

Other commenters indicated that while banks could move their order-taking activities to broker-dealer affiliates (which would not have restrictions on accepting order-taking compensation), many broker-dealers affiliated with banks had expressed concern to them about assuming order execution responsibilities for bank custodial accounts.268 These commenters explained that this concern arises because broker-dealers would have to establish and maintain records for these accounts.269

3. Other Custody and Safekeeping Issues

The Banking Agencies, bank trade groups, and many banks stated that order-taking (accepting and transferring orders), including on behalf of self-directed IRA and 401(k) accounts, is customary and integral to bank custodial activities, and that exemptions would be unnecessary if the Commission recognized that order-taking was inherent in the statute.270 Because of that view, many of these same commenters stated that the Rules are contrary to the statute and legislative history of the GLBA exemption for custody and safekeeping because they exclude order-taking activities.271 The Bank Form Letters stated that the Rules exclude a long list of "customary banking activities" from the custody and safekeeping exception and disrupt a banking service the GLBA specifically protects. 272 Two commenters argued that nothing in the language of the GLBA suggests that depository institutions should not be able to earn fees for providing customary order taking services to their customers.273

One commenter maintained that custodial accounts serve important functions for which brokerage accounts are not suitable, and stated that "pushing out" order taking of banks will require customers to set up duplicative accounts.274 One bank pointed out that that IRS regulations generally require a bank to act as trustee or custodian for IRAs, and stated that thousands of banks offer this service to their customers.275 Commenters also explained that banks providing securities execution services for these accounts save customers the unnecessary expense and administrative complexity of establishing accounts at broker-dealers.276

Several banks opined that Congress clearly intended to allow banks to continue effecting transactions in securities for custodial IRA accounts through the trust exception and the custody exception, and could not have intended to disrupt these traditional bank custodial activities.277 Commenters also maintained that IRA accounts were singled out in subsection (ee) of the custody exception to make it clear that self-directed IRA activities involving securities would remain in banks.278 One commenter argued that the Commission improperly interpreted the custody exception in a manner that disrupts the efficient delivery of services without corresponding benefit to consumers.279

One commenter noted that the Commission staff has recognized that banks play an important role in effecting transactions for benefit plans, and cited a staff no-action letter regarding Universal Pensions, Inc.280 In this commenter's view, the operational realities faced by employers offering various benefit plans would be more complicated if order-taking is not considered part of custody or related administrative services under the exception.281 In contrast, NASAA stated that order acceptance is a sine qua non of broker-dealer activity, and that to allow order acceptance within the safekeeping and custody activities exception would be inconsistent with functional regulation.282

One commenter stated that this exception should clearly encompass escrow agreements and the related services offered by a bank or trust department, which often require that banks effect transactions in securities that are incidental to the bank's role as escrow agent.283 Two commenters stated that securities activities involving escrow agents arguably should be included under subsection (dd) of the safekeeping and custody exception (which provides that a bank may hold securities pledged by a customer to another person).284

One commenter stated that the distinction, made at footnote 174 of the release adopting the Rules, between permissible clearing and settlement functions and impermissible "carrying broker" activities within the custody and safekeeping exemption is not clear.285 This commenter indicated that this issue is especially important when multiple customers have bank accounts for which the bank provides investment management and custody services, as well as accounts with the bank's affiliated broker-dealer for which the bank is a custodian.286 In this commenter's view, a bank might inadvertently become a carrying broker merely by having a large number of accounts, even though the accounts were originated primarily because of the bank's relationship with customers.287

E. Exemption from Section 29 Liability

Exchange Act Rule 15a-8 provides that contracts entered into before January 1, 2003 may not be considered void or voidable solely based on a bank's status as a broker or dealer. We received five comments on this exemption.288

One commenter supported this limited exemption, viewing it as providing important legal protection while banks come into compliance with the new functional regulation structure.289 One bank strongly supported providing banks with additional time to come into compliance with the new provisions, and precluding the ability of private parties to sue banks under section 29(b) during the transition period.290 One commenter opined that banks' civil liability should be limited to customers, or groups of customers, that received services or were parties to transactions.291 Three commenters stated that the time duration for this exemption should be extended if the compliance period is also extended.292

F. Exemption from the Definitions of "Broker" and "Dealer" for Savings Associations and Savings Banks

We received 16 comments on the exemption from the definitions of "broker" and "dealer" for savings associations and savings banks.293 Seven commenters supported the exemption.294 One commenter urged the Commission to clarify that federal savings banks that engage exclusively in fiduciary activities, and that do not accept deposits from the public, may rely on this exemption.295

Eight credit unions, credit union supervisors and credit union trade associations stated that credit unions (including federal and non-federal, as well as corporate and non-corporate) should have been included in this exemption, explaining that credit unions are engaged in networking arrangements, sweep accounts, and safekeeping and custody activities.296 CUNA stated that the Commission, at the very least, should provide credit unions with exemptions for those activities in which they now engage.297 Two commenters expressed the view that extending the exemption to corporate credit unions would not adversely affect investors in need of protections, and would eliminate the unintended legal uncertainty created by the functional exceptions for banks from the definitions of broker and dealer.298

The CIA&B urged the Commission to extend the exemptions for savings associations and savings banks, as well as the exemptions for small banks, to similarly situated insurance agencies and insurance brokerages to ensure that similarly situated financial institutions are not placed at a competitive disadvantage.299 This commenter noted that the Rules give savings banks and thrifts significant flexibility in the types of transactions they can effect without registering as a broker-dealer, and explained that insurance agents and insurance brokers compete with savings banks and thrifts for customers.300 As evidence of the lack of a level playing field, this commenter noted that under staff no-action letters, insurance agencies and insurance brokerages cannot utilize networking arrangements to effect transactions in securities other than insurance securities for their customers.301

G. Exemption from the Definition of "Broker" for Banks That Execute Transactions in Investment Company Securities Through NSCC Mutual Fund Services.

We received 18 comments on the exemption from the definition of "broker" for banks that execute transactions in investment company securities through NSCC Mutual Fund Services ("FundServ").302 Two commenters stated that they appreciated the Commission's effort to recognize the substantial efficiencies that both banks and investment companies can realize by using FundServ to effect transactions in mutual fund shares.303

Four commenters pointed out that not all banks and mutual funds are NSCC members or have opted to use the FundServ system.304 The Bank Form Letters also noted that many mutual funds do not have an affiliated broker-dealer, and that registration with NSCC/FundServ is a lengthy process.305 One commenter opined that because these mutual fund share transactions do not involve open-market trades, they raise no investor protection concerns.306

Two banks asserted that individual investors do not need to go to a registered broker-dealer to purchase mutual fund shares, but may purchase shares through a mutual fund's transfer agent.307 One bank indicated that while it would be possible for banks to stop making purchases directly from a fund's transfer agent, it would be highly disruptive since banks would no longer be able to use their existing automated interfaces.308 Two other commenters explained that banks currently buy and sell securities directly with mutual fund transfer agents through omnibus accounts.309

One commenter stated that when purchase and redemption orders are placed for custody accounts, the custodian may execute trades for some, but not all, of the mutual fund investment options selected by a plan sponsor.310 As explained by this commenter, these accounts are often participant-directed, and it makes no difference to the plan participant if transactions are processed electronically through FundServ, or communicated manually to the fund's transfer agent.311 In this commenter's opinion, if the custodian is merely a passive recipient of purchase and redemption orders, the exemption should apply to all mutual fund orders, regardless of whether they are processed through FundServ.312 Other commenters agreed that the exemption should be extended to allow mutual fund purchases and redemptions to be directed to a fund's transfer agent, and not just through FundServ.313

One bank indicated that the process for trading in its proprietary funds, which are managed by its affiliates, is completely automated between the funds and the funds' transfer agents.314 This bank also noted that because its unlicensed personnel who communicate with fund transfer agents do not also communicate with bank customers, they are not in a position to influence those customers' investment decisions.315

Several commenters viewed the exemption as overly narrow.316 Four commenters stated that it should be extended to include transactions in publicly traded securities conducted directly with an issuer's transfer agent.317 One bank trade group explained that smaller banks sometimes execute transactions on behalf of their customers directly with a mutual fund, and many of the exemptions in the Rules are too restrictive because they are conditioned on transactions being effected through registered-broker dealers.318 In this commenter's view, unless the GLBA specifically requires securities transactions to be effected through a registered broker-dealer, the Commission should allow banks, especially for self-directed IRAs, to effect transactions directly with investment companies.

H. Affiliate Transactions Exception

Exchange Act Section 3(a)(4)(B)(i) permits a bank acting in a broker capacity to effect transactions for the account of any of its affiliates, other than an affiliate that is registered as a broker or dealer or engaged in merchant banking. While none of the Rules addressed this section, the release adopting the Rules clarified that it does not cover a bank effecting transactions with non-affiliated customers, even when the customer transaction is effected as part of a transaction involving an affiliate. As the Commission explained, a bank in this situation would need a separate exception for the customer side of the trade.

We received two comments related to this exception.319 The Banking Agencies argued that the purpose of this exception was to allow banks to continue to facilitate the purchase or sale of securities by their affiliates that are not significantly engaged in securities activities. Explaining that bank affiliates may not have an account at a broker-dealer, the Banking Agencies asserted that a bank's trading desk allows these unregistered affiliates to effect their trades in a cost-effective manner. They also stated that the Commission's view, if read literally, would effectively negate the statutory exception by prohibiting a bank from completing a brokerage transaction under the affiliate exception.320

One commenter stated that under the Commission's interpretation, the exception could only be utilized if two bank affiliates were involved (one on each side of the trade), which it believed would defeat the purpose of the exception.321 In its view, the focus should be on an entire transaction, and not split a transaction into separate purchase and sale components. The ICBA maintained that banks should be able to rely on this exception as long as one of the parties involved in a transaction is a bank affiliate.322

I. Administrative Burden and Cost-Benefit

Some commenters stated that banks will face enormous increased costs in licensing, training, and supervising personnel because they will be subject to multiple regulators.323 One of these commenters opined that the Rules will force trust clients into fragmented relationships with their trustee and a third-party broker-dealer, and will burden them with unnecessary additional costs.324 Another commenter indicated that compliance with the Rules will be very difficult.325 One commenter maintained that while the Rules impose significant burdens, they bring little benefit to fiduciary beneficiaries and customers.326

One bank estimated that its compliance cost would be $10 million.327 Some commenters reported that system providers handling outsourced business for regional and small trusts have estimated the cost for software development would exceed $15 million.328 Other commenters discussed costs in connection with the "chiefly compensated" requirements. Their comments are discussed above in connection with those requirements.

J. Competitive Issues

One bank indicated that, because of the conditions in the Rules, banks will be at a competitive disadvantage with broker-dealers and insurance companies.329 Similarly, another bank explained that one of Congress' overriding goals in the GLBA was to establish a level playing field for financial services providers.330 This bank criticized the Rules, stating that they fail to meet this objective in a number of instances and impose unnecessary burdens on banks.331 This commenter maintained that many of its non-bank competitors, such as broker-dealers and insurance companies, are subject neither to the same burdens nor to the same detailed bank examination supervision and review.

In contrast, the CIA&B indicated that the Rules give savings banks and thrifts, as well as small banks, significant flexibility.332 This commenter asked the Commission to extend exceptions and exemptions applicable to those entities to similarly situated insurance agencies and brokerages to ensure that they are not placed at a competitive disadvantage.333 The CIA&B also asked that the Commission, prior to considering any exemptive applications in this area, set standards for, and to solicit comment on, the circumstances in which individual exemptions from broker-dealer registration would be granted.334 This commenter also asked the Commission to solicit comment before granting specific exemptions to give other financial service providers an opportunity to highlight any competitive issues in advance.335

IV. OTHER ISSUES

A. Requests for a Cure Period

Two commenters stated generally that banks that attempt in good faith to conduct their securities activities in compliance with the exceptions and exemptions, and that have policies and procedures in place that are reasonably designed to ensure compliance, should not be considered broker-dealers merely because some of their securities transactions do not satisfy all conditions of an exception or exemption.336 Commenters also stressed that banks need a cure period for inadvertent noncompliance or unforeseen circumstances.337

A. Dual Employees and NASD Rule 3040

One footnote in the release adopting the Rules outlined the operation of NASD Rule 3040, and noted that it would apply to "dual employees" of banks and broker-dealers. We received 20 comments regarding the application of NASD Rule 3040 to dual employee arrangements and its potential effects on banks with dual employees.338

Eleven commenters noted that they understand the rule to require a "dual employee" effecting a securities transaction in his or her capacity as a bank employee to have the transaction (i) approved by the broker-dealer, and (ii) recorded on the broker-dealer's books and records.339 Eight commenters stated that this broker-dealer oversight of banks' permissible securities activities would also involve NASD and SEC regulation of dual employees functioning in their role as bank employees.340 In their view, theis would contradict the fundamental GLBA principle of functional regulation (i.e., that bank activities should be regulated by the banking regulators). Five commenters asserted that any non-bank regulation of a dual employee arrangement is contrary to congressional intent.341

Commenters also discussed what they perceived as the administrative burden, paperwork, and cost of applying NASD Rule 3040 to banks' dual employee arrangements. Two commenters noted that broker-dealer oversight would require banks to dismantle the internal controls they have in place to separate trust and brokerage accounting systems, monitor transaction and account activity, and separately review personal securities transactions.342 These commenters also stated that a broker-dealer reviewing banking transactions pursuant to NASD Rule 3040 may assume fiduciary liability.343

Another commenter indicated that banks might choose to cease having dual employees rather than be subject to dual regulation.344 This commenter stated that would reduce the likelihood that a bank could attract and retain the best employees. In addition, this commenter pointed out that the securities licenses of former dual employees would lapse, and these persons would have to re-qualify as securities professionals on re-entering employment with a broker-dealer. This commenter also stated that bank employees that do not serve as dual employees would not have the benefit of securities industry continuing education requirement, which this commenter indicated would not be "in the best interest of investors." 345

Two other commenters focused on the benefits that dual employees offer to banks and customers.346 As one commenter explained, "[t]he push-out exceptions should not be applied in a manner that negates the ability of banks to use dual-employee arrangements where doing so will ensure that a properly securities-licensed employee is involved in those transactions triggering push-out and that the same employee can act in his or her bank employee capacity in those transactions not triggering the push-out."347 This commenter stated that using dual employees will significantly reduce the need to "uproot" a customer relationship when only portions of the relationship require the involvement of a licensed securities representative.348

Eleven commenters either urged the Commission to clarify that NASD Rule 3040 does not apply to registered representatives who also are bank employees, or requested the Commission's support in persuading NASD to amend Rule 3040 to ensure that dual employees are subject only to banking regulation.349

B. Other Exceptions Not Addressed by the Rules

Three commenters noted that the Rules do not address the scope of all the exceptions to the definitions of broker and dealer in the Exchange Act.350

One commenter expressed particular concern about any potential future interpretations of the exceptions.351

C. Recordkeeping Requirements

The Banking Agencies and other commenters responded to the Commission's request for comment on whether the Commission should consider adopting recordkeeping requirements.352 Commenters indicated that it is the responsibility of the Banking Agencies, not the Commission, to promulgate banks' recordkeeping rules.353 One commenter also noted that any requirement for extensive recordkeeping would demonstrate the Commission's lack of desire to help the financial industry through a most difficult transition.354

E. Delegation of Authority to Director of Division of Market Regulation.

The Commission delegated to the Director of the Division of Market Regulation the authority to review, and either conditionally or unconditionally grant or deny exemptions to any bank, savings association, or savings bank from the broker-dealer registration requirements of Exchange Act Section 15(a)(1), or other applicable provisions of the Exchange Act and the rules thereunder, based solely on the bank's, savings association's, or savings bank's status as a broker or dealer.355 We received one comment on this delegation of authority. The NCUA stated that the delegation should include authority to grant or deny exemptive relief for credit unions.356

5 The Commission also received 24 letters in response to a separate request for comments on the Notice of Application of Evangelical Christian Credit Union for Exemptive Relief Under Sections 15 and 36 of the Exchange Act and Request for Comment, Securities Exchange Act Release No. 46069 (June 12, 2002), 67 FR 41545 (June 18, 2002) (available at http://www.sec.gov/rules/other/34-46069.htm).

11 See Securities Exchange Act Release No. 46745 (Oct. 30, 2002). Throughout the process of considering amendments to both the bank broker rules and the bank dealer rules, the Commission solicited the views of, as well as factual information from, the Banking Agencies, bank trade groups, individual banks, and other interested parties.

13 See KeyBank letter. This commenter noted that if a bank uses an affiliated broker-dealer for Nasdaq trades, and the affiliate is a market-maker in the security to be acquired, the bank would violate Section 23B of the Federal Reserve Act, which prohibits the purchase of assets in a fiduciary capacity from an affiliate.

17 For example, one individual commenter stated, "[l]ook at what le[d] to the other huge stock market crash in the 1920's! Don't make the same mistake. We must have strict oversight of securities trading inside banks." Letter dated August 2, 2001 from Joshua Tulecke Paulson. See also letter dated August 2, 2001 from Nancy Millar, President, National Organization for Women-NYC ("NOW letter") ("The well-developed history of egregious abuses bestowed on the investing public prior to the enactment of Glass-Steagall, and since its recent repeal, is what the SEC and Congress must look to. To believe that the dynamics of power and greed have been materially altered in nine decades is to engage in naïveté at the public's peril."); letter dated August 6, 2001 from Scott Heinzman (stating it would be naïve for the SEC to relax the regulations pertaining to bank securities activities because the public must have complete faith through adequate oversight and regulation that financial institutions operate ethically at all times).

27 See Central letter, ABA Banking Law Committee letter; Union Bank of California letter; and Wells Fargo letter. Similarly, in a September 23, 2003 meeting, Banking Agency staff told the Commission's staff that some banks pay fees of as much as $100 for referrals of high net-worth customers. Members of the Banking Agencies staff expressed the view that such fees should be considered nominal. The indicated, however, that current referral fees typically range from $5 to $50, with $50 representing the top of the range at large banks in coastal metropolitan areas.

55 See the ABA/ABASA letters; the B of A letter; the BONY letter; the Bank One letter; the Banking Agencies letter; the Federated letters; the FirstMerit letter; the First Union letter; the Fleet letter; the ICBA letter; the Mellon letter; the NYCH letter; the PNC letter; the Shaw Pittman letter; and the UMB Bank letter.

77 See the ABA/ABASA letters; the Bank One letter; the Banking Agencies letter; the Federated letters; the First Union letter; the Frost letter; the ICBA letter; letter dated July 16, 2001 from Bonnie M. Howe, Vice President and Assistant General Counsel, Janus International Holding, LLC, ("the Janus letter"); the KeyBank letter; the Mellon letter; the National City letter; the PNC letter; the Regions letter; the Roundtable letter; the Shaw Pittman letter; the UMB Bank letter; the Victoria letter; and the Wells Fargo letter.

78 See the ABA/ABASA letters; the Federated letters; the First Union letter; the ICBA letter; the Janus letter; the KeyBank letter; the Mellon letter; the National City letter; the Shaw Pittman letter; the UMB Bank letter; and the Victoria letter.

137 In particular, the Commission's release stated that OCC took the position that a national bank may not effect securities transactions for trust accounts through an affiliated broker-dealer, even on a non-profit basis.

146 See the ABA/ABASA letters; the ABA Banking Law Committee letter; the ACB letter;

the Banking Agencies letter; the Bank One letter; the BSA letter; the Fleet letter; the Frost National letter; the Harris Trust letter; the ICBA letter; the IIB letter; the KeyBank letter; the Mellon letter; the NationalCity letter; the NYCH letter; the Regions letter; the Roundtable letter; the TIAA-CREF letter; the UMB Bank letter; the Wells Fargo letter; and the Wilmer, Cutler letter.

156 See the ABA/ABASA letters; the ABA Banking Law Committee letter; the ACB letter;

the Bank Form Letters; the Bank One letter; the Banking Agencies letter; the BONY letter; the Bar of NY letter; the Federated letters; the First Union letter; the Fleet letter; the Frost letter; the Harris Trust letter; the ICBA letter; the KeyBank letter; the Mellon letter; the NASAA letter; the National City letter; the NYCH letter; the PNC letter; the Regions letter; the Roundtable letter; the Shaw Pittman letter; the UMB Bank letter; letter dated August 31, 2001 from Andrew Cecere, Vice Chairman, Private Client and Trust Services, U.S. Bancorp ("the U.S. Bancorp letter"); the Wells Fargo letter; and Zions letters.

161 See the ACB letter; the Bank One letter; the Banking Agencies letter; the BONY letter;

the Federated letters; the Fleet letter; the Frost letter; the Harris Trust letter; the Mellon letter; the NYCH letter; the PNC letter; the Roundtable letter; the UMB Bank letter; and the Wells Fargo letter.

167 See the ABA/ABASA letters; the B of A letter; the Bank One letter; the Banking Agencies letter; the BONY letter; the BSA letter; the Broadway letter; the Federated letters; the FirstMerit letter; the First Union letter; the Fleet letter; the Frost letter; the Harris Trust letter; the ICBA letter; the KeyBank letter; the Mellon letter; the NASAA letter; the National City letter; the NYCH letter; the PNC letter; the Regions letter; the Roundtable letter; the Shaw Pittman letter; letters dated July 16, 2001 and August 28, 2001 from Dave Folz, Executive Vice President, the Texas Capital Bank ("the Texas Capital letters"); Texas Bankers Trust Division letter; the TIAA-CREF letter; the UMB Bank letter; the Victoria letter; the Wells Fargo letter; and the Wilmer, Cutler letter.

170 See the Bank One letter; the Broadway letter; the Federated letters; the FirstMerit letter; the Frost letter; the ICBA letter; the KeyBank letter; the National City letter; the Texas Capital letters; the Victoria letter, the Wells Fargo letter; and the Wilmer, Cutler letter.

179 See the ABA/ABASA letters; the Banking Agencies letter; the B of A letter; the BONY letter; the Bank One letter; the BSA letter; the Federated letters; the Fleet letter; the Harris Trust letter; the ICBA letter; the Mellon letter; the PNC letter; the Regions letter; the Roundtable letter; and the UMB Bank letter.